Fund industry associations challenge SEC securities lending and short position reporting rules

The National Association of Private Fund Managers (NAPFM), Alternative Investment Management Association (AIMA), and Managed Funds Association (MFA) have filed a lawsuit asking the U.S. Court of Appeals for the Fifth Circuit to invalidate two rules recently adopted by the Securities and Exchange Commission (SEC) that require reporting and public disclosure of securities loans and short selling activity.

The industry associations claim although the two closely related rules were finalised on the same day, the SEC disregarded the interconnectedness of the rules and adopted vastly different reporting requirements.

As a result, the rules would apply contradictory and incoherent approaches to two aspects of the same underlying transaction: the short sales themselves and the loans of securities to facilitate those short sales.

In particular, the SEC protects the value of anonymity for short sellers in one rule — where it acknowledges short sellers’ contributions to liquidity and price efficiency — while in the other rule it exposes short sellers’ confidential securities lending and position information on a granular basis, the petitioners said.

They argue that the SEC entirely disregarded the impact of one rule on the other, including by failing to conduct a sufficient cost-benefit analysis of the cumulative impact of both rules.  

Because of these and other flaws, the petitioners claim the rules are arbitrary and capricious under the Administrative Procedure Act and run counter to the SEC’s stated mission to protect investors and maintain fair, orderly, and efficient markets.

The petitioners said they had worked constructively to raise these issues during the rulemaking process and chose to litigate only as a last resort. 

Bryan Corbett, MFA President and CEO said: “Despite our best efforts, the SEC decided to ignore the interconnected nature of these two rulemakings and failed to apply a consistent approach or principle to regulating these related markets. The resulting rules are arbitrary and capricious. The SEC needs to go back to the drawing board and develop a consistent, coherent approach that will protect investors and avoid undermining the resilience of our capital markets.”

AIMA’s CEO Jack Inglis said the two rules underscored how the SEC had ignored calls from industry, market participants, and Congress to consider the interconnectedness and aggregate impact of its rulemakings.

“The rules follow inconsistent approaches with broad extraterritorial scope and contain conflicting analyses and rationale even though they both address similar markets. The rules will impair market efficiency and price discovery and harm market participants and investors,” Inglis said.  “The SEC should instead take into account their connected nature and apply consistent reporting and disclosure frameworks for these positions, which are designed to protect both market efficiency and market participants.” 

Securities lending and short selling are foundational practices for investment and portfolio management. Mutual funds, pension plans, central banks, insurance companies, private funds, broker-dealers, and other sophisticated investors are involved in the lending and borrowing of securities.

Securities lending improves investor returns by providing additional portfolio income, the associations said in a joint statement. Borrowing securities is a necessary component of effecting short sales, which support price discovery, promote market stability, and reduce market risks, they added.      

The associations argue that the newly adopted rules create inconsistent and burdensome reporting regimes that will increase the frequency and detail of disclosure of securities loan and short positions data, allowing market participants to imitate or trade against the underlying position holder, harming investors. In effect, the rules would discourage short selling, they said.  

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